Aggregate supply student

# Aggregate supply student - Aggregate Supply Tradeoff...

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Click to edit Master subtitle style Aggregate Supply Tradeoff Between Inflation and Unemployment

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Topics two models of aggregate supply in which output depends positively on the price level in the short run about the short-run tradeoff between inflation and unemployment known as the Phillips curve
Introduction In previous chapters, we assumed the price level P was “stuck” in the short run. This implies a horizontal SRAS curve. Now, we consider two prominent models of aggregate supply in the short run: Sticky-price model Imperfect-information model

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Introduction Both models imply: ( ) Y Y P EP α = + - natural rate of output a positive parameter expected price level actual price level agg. output § Other things equal, Y and P are positively related, so the SRAS curve is upward- sloping.
The sticky-price model Reasons for sticky prices: long-term contracts between firms and customers menu costs firms not wishing to annoy customers with frequent price changes Assumption: Firms set their own prices ( e.g. , as in monopolistic competition).

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The sticky-price model An individual firm’s desired price is: where a > 0. Suppose two types of firms: firms with flexible prices, set prices as above firms with sticky prices, must set their price before they know how P and Y will turn out: p P a Y Y = + - ( ) p EP a EY EY = + - ( )
The sticky-price model Assume sticky price firms expect that output will equal its natural rate. Then, § To derive the aggregate supply curve, first find an expression for the overall price level. § s = fraction of firms with sticky prices. Then, we can write the overall price level as… Obj103 = p EP

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The sticky-price model Subtract (1 ° s ) P from both sides: price set by flexible price firms price set by sticky price firms § Divide both sides by s : 1 = + - + - [ ] ( )[ ( )] P s EP s P a Y Y 1 = + - - [ ] ( )[ ( )] sP s EP s a Y Y 1 - = + - ( ) ( ) s a P EP Y Y s
The sticky-price model High EP High P If firms expect high prices, then firms that must set prices in advance will set them high. Other firms respond by setting high prices. High Y High P When income is high, the demand for goods is high. Firms with flexible prices set high prices.

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